foreign exchange and currencies
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Foreign Exchange and Currencies. Economics 71a Spring 2007 Mayo, Chapter 6 (skim) Lecture notes 2.6. International Money Flows. Funds flow between countries Two basic reasons Trade flows Investment (capital) flows Central banks also intervene in these markets. - PowerPoint PPT PresentationTRANSCRIPT
Foreign Exchange and Currencies
Economics 71aSpring 2007
Mayo, Chapter 6 (skim)Lecture notes 2.6
International Money Flows
Funds flow between countriesTwo basic reasons
Trade flows Investment (capital) flows
Central banks also intervene in these markets
The Demand and Supply of Foreign Currency
Example: U.S. ($) and France (euros) U.S. consumer buys French wine
+ demand for euros U.S. firm sells ipod to French consumer
+supply for euros U.S. investor buys French stock
+demand for euros U.S. firm sells stock to French investor
+supply for euros
Supply and Demand for Euros
P = $/euro
Q = euros
D
S
The Demand and Supply of Foreign Currency
Example: U.S. ($) and France (euros) U.S. consumer buys French wine
+ demand for euros ($/euro rises) U.S. firm sells ipod to French consumer
+supply for euros ($/euro falls) U.S. investor buys French stock
+demand for euros ($/euro rises) U.S. firm sells stock to French investor
+supply for euros ($/euro falls)
$/euro = exchange rate
Amount of $’s required to purchase 1 euro When this rises
$ price of euro goods rises (imports more expensive)
US consumers of imports worse off Euro price of $ goods falls (U.S. exports cheaper)
US firms exporting better off
And investors feel $ price of euro investments (stocks) rises
US investors holding foreign assets better off Euro price of $ investments (stocks) falls
Foreign investors holding US assets worse off
More Supply/Demand
In the end it is the aggregate of all of these that matters
One other key player: Central bank
Some central banks actively intervene to move (or fix) the exchange rate
Foreign Exchange Markets
Huge marketsOpen 24 hoursMoving both trade and investment flows
Important to international investors
As exchange rates move, values of investments change
Balance of Payments(Measured over fixed period)
Exports - Imports = Trade account >0 Trade surplus <0 Trade deficit
Net new foreign investments = Capital account
<0 net investment flows out of country >0 net investment flows into country
Trade account + net investment income + Capital account = 0
Investment income relatively small
U.S. Balance of Payments
Large trade deficitRelatively small income flowsLarge capital inflows
Borrowing from rest of world Trading IOU’s for goods